Federal program will lower capital gains taxes

Residents in seven New Haven neighborhoods may soon be paying lower capital gains taxes thanks to a federal tax program, though not everyone is enthusiastic about the change.

On Friday, Gov. Dannel Malloy announced that Connecticut will nominate 72 “opportunity zones” across 27 municipalities as part of a new federal tax-incentive program created by the new federal GOP tax legislation. Under this program, each state can nominate up to 25 percent of its low-income communities — defined as census tracts with a poverty rate of over 20 percent or a median income under 80 percent of the state-wide median family income — for federal approval. People who make commercial and residential investments in these zones will be given favorable treatment on the capital gains tax, in an effort to spur economic growth in the zones, with details awaiting further federal decisions.

“One of my administration’s top priorities has been the revitalization, reinvention and growth of our cities,” Malloy said in his Friday announcement. “These opportunity zone nominations we have made will go a long way in encouraging new investment and development in areas that will be critical to Connecticut’s future.”

According to Rob Michalik, government relations director for the state Department of Economic and Community Development, municipalities submitted a ranked list of eligible tracts to the state, which then selected one fourth of them for nominations. Selection criteria included the area’s development potential, economic need and other factors including prospective transit projects and the state’s existing investments, Michalik said. The federal government is expected to mostly honor states’ recommendations.

Once enacted, the program will allow people to place capital gains from previous investments in “opportunity funds,” which will flow to development projects in designated areas, Michalik said. By doing so, the people can pay a smaller portion of the original taxes at a later date. Michalik acknowledged the program’s fluid future but remained hopeful that it can be effective under sound management.

“It is an open question as to how this program is going to be,” Michalik said. “We will have to come forward as a state, in conjunction with communities, to present these opportunities to investors so they see the potential. Once the designations are made, this is likely to be our next step.”

Others are more skeptical of the program’s potential.

Matthew Nemerson SOM ’81, New Haven’s economic development administrator, told the News that the federal government has yet to lay out the specifics for this program, sowing doubt and confusion in localities. While the program holds has the potential to spur economic growth in low-income neighborhoods, Nemerson said, the vague rules currently in place may also make it a “capital black hole” for people to avoid paying capital gains taxes.

Nemerson said that whereas previous initiatives to revive low-income areas, such as enterprise zones or empowerment zones, also provides tax relief for investments, the opportunity zone program is the first to focus on capital gains taxes. Judging by similar programs in the past, a cottage legal industry is likely to emerge and focus on ways to circumvent taxation by “recycling” capital gains into development projects, Nemerson said.

The seven census tracts in New Haven that received recommendations include portions of the Hill, Long Wharf, Fair Haven, Wooster Square, Dixwell and Newhallville neighborhoods.

Many economists also have pessimistic outlooks on the program. Adam Looney, senior fellow at the Brookings Institution, cautioned that the program may be less effective than some previous efforts, including empowerment zones, a program created by the administration under former President Bill Clinton LAW ’73. One major reason, Looney said, is that the capital gains tax applies to only about 5 percent of the U.S. population, precluding engagement by the vast majority of residents and small businesses. The capital gains-oriented nature of the program is likely to limit how much it stimulates real estate developments, and states’ emphasis on “development potential” often excludes more distressed communities.

“From the past we saw a lot of benefits went to projects that would have occurred anyway.” Looney said. “[For this program], we have seen in some of states where the places picked are in much better shape than those rejected.”

Lotta Moberg, macroeconomic analyst at William Blair, a financial services firm, said that while the program may divert investments from more promising areas into more distressed neighborhoods, which tend to have a lower development potential, it is nevertheless similar to other redistributive policies that trade net outcome for more equity. One major pitfall, she warned, is that governments often make mistaken judgements in evaluating the need and potentials of different areas in a free market, dampening the program’s efficacy.

Still, state and local officials are gearing up for implementation efforts in the coming months. Michalik noted that communities in Connecticut will face competition from similar zones of other states, raising the stakes for states’ recruitment campaigns. Nemerson said the city will focus on the federal government’s pending decisions on the program and how it plays out across the nation.

“We will be looking very carefully at how other states allocated their districts,” Nemerson said.

Ten census tracts in Hartford were nominated to become opportunity zones, as well as seven tracts in Bridgeport.